Syeda Umyma Faiz

ERP: 25895
Institute of Business Administration,
Karachi Principles of Microeconomics
Session: Fall 2022
Assignment # 5

1. A recent study found that the demand-and-supply schedules for Frisbees are as
follows:

a. What are the equilibrium price and quantity of Frisbees?

Equilibrium price of Frisbees = $8

Equilibrium quantity of Frisbees = 6 million

b. Frisbee manufacturers persuade the government that Frisbee production improves

scientists’ understanding of aerodynamics and thus is important for national security.
A concerned Congress votes to impose a price floor $2 above the equilibrium price.
What is the new market price? How many Frisbees are sold?

The new market price is $10.

Quantity sold for frisbees is 2 million.

c. Irate college students march on Washington and demand a reduction in the

price of Frisbees. An even more concerned Congress votes to repeal the price floor
and impose a price ceiling $1 below the former price floor. What is the new market
price? How many Frisbees are sold?

The new market price is $9.

Quantity sold for frisbees is 4 million.
2. At Fenway Park, home of the Boston Red Sox, seating is limited to about 38,000. Hence, the
number of tickets issued/supplied is fixed at that figure. Seeing a golden opportunity to raise
revenue, the City of Boston levies a per ticket tax of $5 to be paid by the ticket buyer. Suppose
the initial price per ticket is $10. Boston sports fans, a famously civic-minded lot, dutifully send
in the $5 per ticket.

a. Draw a well-labeled graph showing the impact of the tax.

b. On whom does the tax burden fall—the team’s owners, the fans, or both? Why?

As the graph is perfectly inelastic, the tax burden falls completely upon the consumers (fans). This is
because the 38000 fans (maximum number od seats available) are willing and able to pay the higher
price for the tickets.

3. Evaluate the following two statements. Do you agree? Why or why not?
a. “A tax that has no deadweight loss cannot raise any revenue for the government.”

I disagree with statement. A tax which has no deadweight loss will have no effect on the quantity sold,
hence it will not generate any revenue for the government. Such a case can be seen when the demand or
supply of a good is perfectly inelastic. The imposition of tax will not bring any change in the quantity
demanded if the demand is perfectly inelastic.

b. “A tax that raises no revenue for the government cannot have any deadweight loss.”

I disagree with statement. If the tax raises no revenue for the government, then there will be a large
deadweight loss. When the tax rate imposed on sale of goods is very high, for example, 90%, the seller
will not supply the goods at all (or at quantity supplied will fall significantly). Therefore, the tax will fail
to raise government revenue. However, this will result to a large deadweight loss as the tax reduces the
quantity sold.
4. The market for pizza is characterized by a downward-sloping demand curve and an
upward-sloping supply curve.
a. Draw the competitive market equilibrium. Label the price, quantity, consumer surplus, and
producer surplus. Is there any deadweight loss? Explain.
HINT: Put some numbers of the graph so that you can show your calculations of imposing a
$1 tax in part b.

They will be no dead weight loss because supply and demand are in equilibrium which means
that the market is operating efficiently. Deadweight loss occurs due to market in efficiency when
allocated efficiency is not achieved.

b. Suppose that the government forces each pizzeria to pay a $1 tax on each pizza sold. Illustrate
the effect of this tax on the pizza market, being sure to label the consumer surplus, producer
surplus, government revenue, and deadweight loss. How does each area compare to the pre-tax
case?
HINT: Pick a starting point for your analysis as mentioned in the class, so that you pre- tax and
post-tax analysis makes sense.
Pre-tax:
Consumer surplus = Area A+ Area B + Area E = (½ * 20 * 2.5)+ (0.5 * 20)+ (½ * 10 * 0.5) = $37.5
Producer surplus = Area C + Area D + Area F= (0.5 * 20)+(½ * 2 0* 2.5)+ (½ * 10 * 0.5) = $37.5
Government Revenue= 0
Deadweight Loss= 0

After Tax:
Consumer surplus = Area A= ½ * 20 * 2.5 = $25
Producer surplus = Area D = ½ * 20 * 2.5 = $25
Government Revenue= Area B + Area C = (0.5 * 20) + (0.5 * 20) = 10 + 10= $20
Deadweight Loss= Area E + Area F= (½ * 10 * 0.5) + (½ * 10 * 0.5) = 2.5 + 2.5 = $5

With a $1 tax on each pizza sold, the price paid by consumers, $3.5, is greater than the price received by
sellers, $2.5, as Tax=$3.5-$2.5=$1. The quantity decreases from 3 to 2. The consumer surplus decreased
from $37.5 to $25 (A+B +E to A). The producer surplus decreased by $12.5 (C+D+F to D). The
government revenue increased due to imposition of tax by $20 (B+C) resulting to deadweight loss of $5
(E+F).

c. If the tax were removed, pizza eaters and sellers would be better off, but the government would
lose tax revenue. Suppose that consumers and producers voluntarily transferred some of their
gains to the government. Could all parties (including the government) be better off than they
were with a tax? Explain using the labeled areas in your graph.
HINT: Think of the total surplus including government revenue when solving this part. Remember
there is no loss of consumer and producer surplus in this part as the payment of tax is voluntary
(meaning the buyers and sellers are sharing part of their surplus while being fully aware of the
situation).

Removing the tax will result in Consumer surplus being Area A+ Area B + Area E and producer surplus
being Area C + Area D + Area F, leaving the government revenue as 0.
If the consumer and producer transfer some of their gains to the government then everyone will be better
off. The consumers will transfer some part of the area E to the government and the producers will
transfer some part of the area F to the government. This will reduce the deadweight loss; hence all the
parties will be better off.